November 27, 2019

Lemon Tree Hotels Limited: Rating assigned for enhanced amount

Summary of rating action Previous Current Rated Rated Instrument* Rating Action Amount Amount (Rs. crore) (Rs. crore) Long-term Fund-based – Term Loan 99.37 116.00 [ICRA]A- (stable); assigned/outstanding Long-term/ Short -term – Fund Based 30.00 30.00 [ICRA]A- (stable)/ [ICRA]A2+; outstanding Working Capital Short-term/ Short-term – Unallocated 4.11 0.00 - Total 133.48 146.00 *Instrument details are provided in Annexure-1

Rationale ICRA has taken a consolidated view of Lemon Tree Hotels Limited (LTHL), its subsidiaries, step-down subsidiaries and associate companies (the Lemon Tree Group) while assigning the credit rating, given the common management and significant operational and financial linkages between them.

The rating assignment/reaffirmation factors in the consistent improvement in the financial and operating metrics of LTHL’s hotel portfolio in FY2019 owing to favourable demand environment across operative micro-markets. This enabled an improvement of 7% on a YoY basis in average room revenues (ARRs) coupled with steady occupancy of over 75%. On a consolidated level, the company reported a 13.5% and 24% YoY growth in operating income (OI) and OPBDIT, respectively, in FY2019. While there was delay in the launch of its (city centre) and Mumbai (Andheri) properties, the ramp-up since their eventual launch (in December 2018 and June 2019, respectively) has been healthy and is expected to contribute meaningfully to profitability, going forward. In H1 FY2020, despite weak macroeconomic conditions and one-off events—such as the general elections and airline industry issues—the company reported steady occupancy levels and 3.8% average YoY growth in ARRs. Lemon Tree Premier Kolkata and ‘Aurika’ (Rajasthan) were launched in Q3 FY2020, and given these high demand markets, they are expected to ramp-up swiftly.

The rating continues to reflect ICRA’s expectation of continued improvement in the performance metrics of LTHL’s portfolio led by the improving maturity profile of its assets and ramp-up of new projects launched in demand-dense markets (Pune, Mumbai, Udaipur and Kolkata), even as overall demand growth prospects for the hospitality sector appear subdued in the near term. Furthermore, with only three projects under development, the project implementation risk stands substantially reduced.

The rating continues to favourably factor in the diversified geographical presence of the Group hotels, the well- recognised, in-house brands such as Lemon Tree and Red Fox, its comfortable capital structure and extensive experience of the promoter in the hospitality industry. ICRA notes the favourable location of the properties (in prominent business districts with remunerative catchments) and portfolio expansion through an asset-light business models—viz. leasing of properties and management contracts. Although the properties at Aerocity, (Hitech City and

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Gachibowli) and (Ulsoor Lake and Electronic City) drive a significant proportion of the company’s revenues (~49% in FY2019), which exposes it to the risks of adverse region-specific development, the hotel portfolio is reasonably diversified across categories (upper mid-scale/midscale/economy) with presence in dispersed micro-markets. The same reduces the vulnerability of revenues to cyclical downturns or regional events to some extent. In July 2019, LTHL had announced the acquisition of Berggruen Hotels (BHPL), owner of the ‘Keys’ brand and a 1,911- room hotel portfolio in . The acquisition carried out under FHPL (a 58% subsidiary of LTHL, with balance ownership by APG Asset Management Company or APG), was concluded on November 1, 2019 and BHPL became a 100% subsidiary of FHPL. Of the purchase consideration of Rs. 471 crore, APG infused fresh equity of Rs. 360 crore (76%) into FHPL in October 2019. The balance amount was funded by LTHL from internal accruals. This will limit any adverse impact on LTHL’s capital structure. On the operational front, the acquisition will provide LTHL ready access to new cities and potential to add hotels under new brands (Keys Prima, Select and Lite), without diluting its existing brand offering. This will augment LTHL's market share in the mid-scale hotel segment. Post-acquisition, hotels in Bangalore and Pune are expected to be rebranded as Lemon Tree hotels involving marginal capex (Rs. 10-15 crore), while others will continue under existing brands. BHPL’s performance, over the near to medium term, is expected to reflect synergistic benefits from LTHL’s established client base, marketing network, relationship with online travel agents (OTAs) and lenders. The company expects the Keys portfolio to generate gross operating profits of up to Rs. 50 crore in FY2020 (as against Rs. 32 crore in FY2019) with marginal impact on LTHL’s consolidated debt levels.

The rating is, however, constrained by moderate return indicators (i.e., RoCE of 7.4% in FY2019) as investments in newly launched properties (Sector 60, Gurgaon, Banjara Hills, Hyderabad and City Centre, Pune) are yet to scale up adequately for meaningful contribution to profitability. Moreover, while the execution risk has reduced following planned launch of five (876 rooms) of the seven under construction properties over the last 15 months, the company has leveraged these new properties to fund the on-going capex in remaining projects. This debt-funded expansion over FY2020-FY2022, and incremental debt of Rs. 134 crore, related to the acquisition of BHPL, is expected to keep the financial leverage (TD/ OPBITDA) of LTHL elevated over the medium term, despite ramp-up of cash accruals from the operational portfolio. While project debt is yet to be tied up for the Mumbai Airport project, ICRA does not anticipate any delays in financing tie-up given the favourable location and almost entire project equity having been invested upfront. With ballooning debt repayments, the coverage indicators are also expected to remain muted. Nontheless, ICRA draws comfort from company’s financial flexibility emanating from its healthy asset base and management’s demonstarted track record of raising timely debt against projects, top up loans on operational properties and refinancing of high cost debt. Further, ICRA takes cognizance that the successful public listing of equity shares in FY2019 has improved LTHL’s financial flexibility, in terms of better access to capital markets and liquidity for shareholders.

The rating also reflects the cyclical nature of the industry, with financial performance being prone to seasonality as well as economic growth. Compared to the 10% growth in FY2019, ICRA expects a muted industry revenue growth (~6%) in FY2020e due to weak demand. However, post FY2020, the demand is expected to pick up gradually with a compound annual revenue growth expectation of 8-9% during FY2020-FY2024.

Further, the Indian budget hotel segment is characterised by relatively low entry barriers and numerous unorganised players. Thus, LTHL faces intense competition from standalone hotels in key micro-markets, organised players like Ginger, Ibis and Holiday Inn Express, and room aggregators like OYO, which may constrain its ability to scale-up revenue per available room (revPAR) and impact scale-up of profitability at anticiapated pace.

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The Stable outlook on the rating reflects ICRA’s expectation that LTHL will continue to benefit from the geographically diversified and differentiated brand portfolio and a favourable medium-term demand outlook for the industry. Further, with the next phase of organic inventory expansion planned in FY2022–FY2023 (Mumbai Airport project), the current portfolio would get an ample time for stabilisation. Also, since all the recent launches have been in demand dense markets—Pune, Mumbai, Kolkata and Udaipur—these are expected to have comparatively shorter gestation period and thereby faster turnaround, supporting the overall portfolio metrices over the medium term.

Key rating drivers and their description

Credit strengths Healthy revenue growth; revenue visibility led by favourable demand-supply dynamics and BHPL portfolio integration – LTHL reported a 19% growth in revenues on a YoY basis in H1 FY2020, led by ramp-up of new inventory (Mumbai, Pune, and ) and steady performance across other mature properties. While the portfolio occupancy declined marginally to 76.1% in H1 FY2020 as against 77.5% in corresponding previous, portfolio revPAR improved by nearly 4% in the same period. The 12% increase in OPBITDA (pre Ind-AS 116 adjustment) was relatively lower, impacted by nearly 700 rooms in early stabilisation phase, minimum wage revisions across several states and increase in provident fund contributions. ICRA expects the FY2020 pan India revPAR growth to remain muted, impacted by the subdued demand environment. While the upcycle is likely to be impacted for a brief period, the strong demand expected over the medium term coupled with improving maturity profile of the LTHL portfolio and continued favourable guest mix, is likely to facilitate an improvement in ARR and occupancy, going forward. Further, with acquisition of the Key’s hotel portfolio, LTHL will be able to access a few currently unpenetrated markets, enhance presence in key markets like Bengaluru and Pune, and take up hotel enquires (for management contract) under new brands, which were earlier not tenable with the existing brands. ICRA expects the Key’s portfolio to benefit from LTHL’s extensive marketing network and established relationship with OTAs and register healthy improvement in performance and augment consolidated portfolio performance.

Equity infusion from APG to support capital structure – Of the total purchase consideration of Rs. 471 crore for the acquisition of Keys hotel portfolio, FHPL received Rs. 421 crore share subscription money from APG and LTHL in October 2019. Nearly 76% fresh equity infusion to fund the inorganic growth will limit any impact on the capital structure of the consolidated entity. Healthy equity infusions from private equity players (Warburg Pincus and APG) in the past has helped LTHL maintain a comfortable capital structure (TOL/TNW of ̴1.0 time) despite undertaking significant and consistent capex towards portfolio expansion. The management policy of relying on debt against cash flows of operational properties for funding ongoing projects, deferment of project debt towards later stages and its ability to raise low cost debt, continues to be a credit positive for LTHL.

Reduced project implementation risk; strategy to expand through management contract route to limit capital requirement and minimise risk – The project implementation risk faced by LTHL stands significantly reduced following the launch of five of the seven projects under implementation in the last 15 months including the recent launch of ‘Aurika’ in Udaipur. Furthermore, the company plans to expand through an asset-light model that involves leasing properties or entering into management contracts with property owners. These models are expected to provide long- term operational benefits to LTHL, as properties can be quickly put in operations with minimal (or nil) capex and limited project implementation risk. Furthermore, the company would be able to conserve its funds while increasing its network, allowing scope for faster scale-up of revenues and profitability. 3

Well-recognised brands and geographically diversified product portfolio - LTHL is one of India’s largest hotel chains, with 57 operational properties (as on June 30, 2019) across 34 cities. The company has a well-established and recognised mid-scale (Lemon Tree) and economy segment (Red Fox) brands. It also benefits from a robust distribution system, loyalty programmes and corporate relationships. Additionally, the diversified presence reduces the vulnerability of the Group’s revenues to cyclical downturns to some extent, while the favourable location of its properties in prominent business and tourist districts supports revenue growth and reduces concentration risk. Experienced promoters and management team – LTHL is promoted by Mr. Patu Keswani, who has been associated with the hospitality industry for over 30 years. The management team is also experienced and has a track record of delivering consistent performance through well-planned refurbishment, professional centralised sales and marketing and disciplined cost control. From mere two properties in 2004, the Group had expanded its portfolio to 57 properties (owned/leased and managed) as at June 30, 2019 under its three in-house brands.

Credit challenges Financial profile characterised by moderate leverage, RoCE and muted debt coverage - Nearly one-third of the company’s operational owned/leased inventory was in stabilisation phase as on September 30, 20191 (over three years since commencement of operations) and is yet to meaningfully start generating profits. Since debt has been availed against these properties to fund the ongoing capex, the RoCE has remained muted at 7.4% in FY2019. With plans to mobilise debt over FY2020-FY2022 for the under-construction projects, the consolidated leverage (TD/ OPBDITA), at ~7.1x as on March 31, 2019, is likely to remain high (above 5x). However, with improvement in operating profits and scheduled repayment obligations, the debt coverage ratios are expected to improve, over the medium term. ICRA derives comfort from the management’s demonstrated track record of refinancing debt at favourable terms. Focus on network expansion via management contract route would limit capex requirement and support growth in returns over the long-term.

High competition in the budget segment; performance of upscale brand “Aurika” remains to be seen– The midscale and economy hotel segment in India is primarily unorganised and characterised by relatively low entry barriers. With the foray of several organised chains, the competition has intensified over the years given the expansion by brands, such as Ibis, Holiday Inn Express and Ginger. The emergence of room aggregators also puts pressure on the branded economy segment hotel operators as it widens the available room inventory to guests by bringing in several independents on the platform. While LTHL has stated its intention of diversification into the upscale segment with the launch of “Aurika” Udaipur in FY2020, the market acceptance and pace of expansion of the brand remains a monitorable factor over the medium term.

Vulnerability of revenues to inherent industry cyclicality, economic cycles and exogenous events - Operating performance of the properties remain vulnerable to seasonal industry, general economic cycles and exogenous factors (geo-political crises, terrorist attacks, disease outbreaks, etc). Nonetheless, the risk to revenues is partially mitigated by LTHL’s geographically diversified portfolio in prominent business districts, which allows it to withstand any demand vulnerability related to a particular micro-market.

1 Including the 142-room Kolkata property, which was launched in mid-October 2019.

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Liquidity position: Adequate LTHL’s liquidity has remained Adequate with positive cash flows from operations in the past few years. The company had cash and liquid investments of Rs. 118 crore as of September 30, 2019 and limited working capital utilisation levels (against sanctioned lines of Rs. 130 crore). Major funding requirements in FY2020 emanate from capex commitment of nearly Rs. 250 crore and repayment obligations of approximately Rs. 60 crore. In addition, some loss-funding for properties undergoing stabilisation may also be required. ICRA expects LTHL to be able to meet its near-term commitments through internal cash flows as well as drawdown of project debt. Large asset base and financial flexibility with its lenders also support refinancing options and liquidity profile.

Rating sensitivities Positive triggers – ICRA could upgrade LTHL’s rating if the company demonstrates a sustained improvement in its operational metrices leading to improvement in ROCE and reduction in leverage metrics on a consolidated basis. Specific credit metrics that could lead to an upgrade of LTHL’s rating include Total Debt/ OPBITDA below 5.0 times and DSCR over 1.5x on a sustained basis.

Negative triggers – Negative pressure on LTHL’s rating could arise for reasons including a shift in the industry conditions leading to slower than anticipated growth in portfolio revPAR and lower operating margins and/or increase in debt- funded capex (organic or inorganic) resulting in delay in improvement in return and leverage metrices. Weakening of operational and financial linkages among the Group entities could also adversely impact the rating. Since the company is in its growth phase, with a sizable acquisition of the Key’s hotel portfolio likely over the near term, timely funding from APG and seamless integration of new business with the existing portfolio remain monitorable factors. The extent and manner of funding the investment in the co-living space (JV with Warburg) also remains a monitorable factor. Analytical approach

Analytical Approach Comments Corporate Credit Rating Methodology Applicable Rating Methodologies Rating Methodology for Entities in the Hotel Industry Consolidation and Rating approach Parent/Group Support NA For arriving at the rating, ICRA has considered the consolidated financials of LTHL. As on March 31, 2019, the company had 17 subsidiaries, nine stepdown Consolidation/Standalone subsidiaries (subsidiaries under indirect control), three associates, and a limited liability partnership, which are enlisted in Annexure-2.

About the company Incorporated in 2002 by Mr. Patanjali Keswani and his friends and associates, LTHL is a public listed company that owns and operates hotels under three brands—Lemon Tree Premier (upper mid-scale), Lemon Tree (midscale) and Red Fox (economy)—across 34 Indian cities (in June 2019). In terms of ownership, ~31% stake in the company is held by the promoters (Keswani family), ~15% by APG (a Dutch pension fund) and the rest by foreign portfolio investors, mutual funds, employees and the public.

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LTHL designs, develops, and manages properties under its own books as well as its subsidiaries’ books (collectively referred to as the Lemon Tree Group). While most of the properties in the portfolio are owned by the company directly or through subsidiaries, a few are operated on long-term lease basis. As on October 31, 2019, the Group had 34 owned/leased operational properties and two properties under development. The total owned/leased inventory across the operational properties stood at 4,256 rooms. The 748-room under development properties, moreover, are expected to be added to the portfolio over the next three years.

To facilitate the rapid expansion of LTHL’s brands across the country, the Group’s subsidiary, Carnation Hotels Private Limited, usually enters into management contracts with asset owners. As on September 30, 2019, 1,853 rooms across 26 properties were under management contracts with additional 2,056 rooms under negotiation.

In November 2019, LTHL also completed the acquisition of Berggruen Hotels Private Limited, a company owning and operating hotels under various brands, such as Keys Prima, Keys Select and Keys Lite in India. With this acquisition, LTHL now owns the ‘Keys’ brand and has added seven hotels (936 rooms) and 14 managed properties (975 rooms) to its portfolio.

Key financial indicators (audited) LTHL Consolidated FY2018 FY2019 H1 FY2020* Operating Income (Rs. crore) 484.3 549.5 293.7 PAT (Rs. crore) 14.0 55.6 -4.6 OPBDIT/OI (%) 28.1% 30.7% 31.7% RoCE (%) 5.8% 7.4% --

Total Outside Liabilities/Tangible Net Worth (times) 1.0 1.1 1.5 Total Debt/OPBDIT (times) 7.4 7.1 -- Interest Coverage (times) 1.7 2.0 1.5 DSCR (times) 1.2 1.3 -- *Published H1 FY2020 results, post Ind-AS 116 adjustment PAT: Profit after Tax; OPBDIT: Operating Profit before Depreciation, Interest, Taxes and Amortisation; ROCE: PBIT/Avg (Total Debt + Tangible Net Worth + Deferred Tax Liability - Capital Work in Progress); DSCR: (PBIT + Mat Credit Entitlements - Fair Value Gains through P&L - Non-cash Extraordinary Gain/Loss)/(Interest + Repayments made during the Year)

Status of non-cooperation with previous CRA: Not applicable

Any other information: None

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Rating history for past three years Current Rating (FY2020)^ Chronology of Rating History for the past 3 years Amount Amount Date & Rating in Date & Date & Date & Date & Rated Outstanding Rating Rating in Rating in Rating in (Rs. as of Sep 30, FY2019* FY2018 FY2017 crore) 2019 Instrument Type (Rs. crore) 27-Nov-19 5-Nov-19 8-Jul-19 15-Jun-18 27-Apr-17 1-Jun-16 Long- [ICRA]A- [ICRA]A- [ICRA]A- [ICRA]A- [ICRA]BBB+ 1 Term Loans 116.0 105.69 [ICRA]A-& term (Stable) (Stable) (Stable) (Stable) (Stable) Long- Fund based term [ICRA]A- [ICRA]A- [ICRA]A- [ICRA]A- [ICRA]BBB+ [ICRA]A-&/ 2 bank and 30.0 -- (Stable)/ (Stable)/ (Stable)/ (Stable)/ (Stable)/ [ICRA]A2+& facilities short [ICRA]A2+ [ICRA]A2+ [ICRA]A2+ [ICRA]A2+ [ICRA]A2 term Long Term [ICRA]A- [ICRA]A- [ICRA]A- Unallocated [ICRA]A-&/ [ICRA]BBB+ 3 and ------(Stable)/ (Stable)/ (Stable)/ Limits [ICRA]A2+& (Stable) short- [ICRA]A2+ [ICRA]A2+ [ICRA]A2+ term *Other PRs published in FY2019 included update on material events released on Jan 3, 2019 and Mar 19, 2019. No change in rating outstanding in these PRs; ^A PR for update on delay in periodic surveillance was published on Sep 27, 2019 in FY2020.

Complexity level of the rated instrument ICRA has classified various instruments based on their complexity as "Simple", "Complex" and "Highly Complex". The classification of instruments according to their complexity levels is available on the website www.icra.in

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Annexure-1: Instrument details Date of Amount Coupon Maturity ISIN No Instrument Name Issuance / Rated Current Rating and Outlook Rate Date Sanction (Rs. crore) NA Term Loan-I Nov 2017 NA FY2024 17.70 [ICRA]A-(Stable) NA Term Loan-II Mar 2014 NA FY2024 16.95 [ICRA]A-(Stable) NA Term Loan-III Apr 2016 NA FY2026 19.32 [ICRA]A-(Stable) NA Term Loan-IV Apr 2017 NA FY2025 9.49 [ICRA]A-(Stable) NA Term Loan-V Apr 2015 NA FY2021 7.23 [ICRA]A-(Stable) NA Term Loan-VI Oct 2019 NA FY2031 45.00 [ICRA]A-(Stable) NA Overdraft limit NA NA NA 30.00 [ICRA]A-(Stable)/A2+ Source: Company Annexure-2: List of entities considered for consolidated analysis LTHL Consolidation Company Name Ownership Approach 100.00% Full Lemon Tree Hotels Limited (rated Consolidation entity) Full Begonia Hotels Private Limited 74.11% Consolidation Full Carnation Hotels Private Limited 74.90% Consolidation Full Fleur Hotels Private Limited 57.98% Consolidation Full Dandelion Hotels Private Limited 100.00% Consolidation Lemon Tree Hotel Company Private Limited 100.00% Full Consolidation Full PSK Resorts & Hotels Private Limited 100.00% Consolidation Full Canary Hotels Private Limited 100.00% Consolidation Grey Fox Project Management Company Private Limited 100.00% Full Consolidation Full Nightingale Hotels Private Limited 100.00% Consolidation Full Oriole Dr Fresh Hotels Private Limited 100.00% Consolidation Full Red Fox Hotel Company Private Limited 100.00% Consolidation Full Sukhsagar Complexes Private Limited 100.00% Consolidation Full Manakin Resorts Private Limited (Subsidiary of PSK Resorts & Hotels Private Limited) 10.00% Consolidation Full Meringue Hotels Private Limited 59.48% Consolidation Full Poplar Homestead Holdings Private Limited 100.00% Consolidation Full Madder Stays Private Limited 100.00% Consolidation 8

LTHL Consolidation Company Name Ownership Approach Full Jessamine Stays Private Limited 100.00% Consolidation Full Manakin Resorts Private Limited (Subsidiary of PSK Resorts & Hotels Private Limited) 90.00% Consolidation Full Celsia Hotels Private Limited (Subsidiary of Fleur Hotels Private Limited) 57.98% Consolidation 57.98% Full Inovoa Hotels & Resorts Limited (Subsidiary of Fleur Hotels Private Limited) Consolidation 59.66% Full IORA Hotels Private Limited (Subsidiary of Fleur Hotels Private Limited) Consolidation 57.98% Full Hyacinth Hotels Private Limited (Subsidiary of Fleur Hotels Private Limited) Consolidation 57.98% Full Bandhav Resorts Private Limited (Subsidiary of Fleur Hotels Private Limited) Consolidation 57.98% Full Ophrys Hotels Private Limited (Subsidiary of Fleur Hotels Private Limited) Consolidation Valerian Management Services Private Limited (Subsidiary of Grey Fox Project 100.00% Full Management Company Private Limited) Consolidation Meringue Hotels Private Limited (Subsidiary of Dandelion Hotels Private Limited upto 40.52% Full September 1, 2017) Consolidation Mind Leaders Learning India Private Limited 36.56% Equity Method Pelican Facilities Management Private Limited (Subsidiary of Mind Leaders Learning 36.56% Equity Method India Private Limited) Hamstede Living Private Limited 30.00% Equity Method Mezereon Hotels LLP (Capital contribution by Fleur Hotels Private Limited & Celsia 57.98% Full Hotels Private Limited) consolidation Source: LTHL annual report FY2019

Note: ICRA has taken a consolidated view of the parent (LTHL), its subsidiaries and associates while assigning the rating.

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Analyst Contacts Subrata Ray Shamsher Dewan +91 22 6114 3408 +91 124 4545328 [email protected] [email protected]

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For more information, visit www.icra.in

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